Even if you were buying a home as an investment, real estate tends to go through boom and bust cycles. During boom times it is common for homes to go to the highest bidder on the first day, for higher than the asking price. It’s easy to get caught up in this excitement, joining the rush to “invest” in this hot market—to jump on the train before it gets away from you forever.
But is real estate a good investment all of the time?
Just look at former real estate boom areas when the bust part of the cycle comes. People have to confront the fact that their house has not been a good investment. In many cases, their home has depreciated considerably in value since they bought it. Imagine living in your home for years, and then selling for a price that is less than the remaining balance on your mortgage. You would have to pay money just to get out of it!
Sometimes, people find they can’t sell their house for a long time after they place it on the market, or they can’t sell it at all. Recently one of my clients moved to Seattle from Washington, D.C. Originally, the house she had left in D.C. was by all appearances a great place to have bought a home. It’s located close to the government office buildings and in sight of the Washington Monument. But the neighborhood has “transitioned” the wrong way—toward deterioration rather than renovation. Now she can’t sell her house for what it cost, and she has to rent it out to keep up the payments.
In boom times, we don’t like to think that the market may one day fall. We don’t like to think about the possibility that we may not recover what we paid for our home originally, or that we won’t be able to sell it at all. But it happens.
We hear stories of people who made a killing in real estate. In a lot of cases, they entered the real estate market as a business, buying and selling rental homes or buildings. But most of us are in the situation of owning just our principal residence. For us, selling and moving to a new residence is not a moneymaking endeavor—it is a move to a new home.
Some people do realize a gain from the sale of their principal residence if they then move to an area where real estate is less expensive. For instance, I know a couple who sold their California home and bought a twelve-acre spread in Montana, and they still had money to spare. But such a move involves a lifestyle choice as well as a financial one. Moving to a rural area often entails a loss of access to amenities and cultural opportunities that people in urban settings usually enjoy and take for granted.
Another factor people tend to forget is the cost of buying and selling. In the Pacific Northwest, it usually costs 1.5% of the cost of the house to buy a home and 8.5% to sell it. Your home has to appreciate 10% just to break even.
I also want to debunk the often-heard, “I bought a house so I could get the tax write-off.” People justify their home as a good investment because they get a tax deduction for interest and real estate taxes.
They forget that it is not a dollar for dollar deduction. For instance, if you are in a 28% tax bracket and you spend a dollar on mortgage interest, you will get 28 cents back in tax savings. Paying a dollar to end up with 28 cents is not good financial planning. A tax write-off for a home is no reason to buy.
Of course, you need a roof over your head. Buy a house in an area you want to live. Buy a home you can afford. Don’t rationalize your decision to buy a more expensive home because you think it is a good investment or because it is a good tax write-off. Unless you intend to sell it eventually, and then downsize or rent a home and live off the gain, its increase in value is irrelevant. The only thing you gain in the meantime is an increase in your property taxes.
Kept in its right perspective, owning a home is a great thing. But it is not the crown jewel of your financial plan. For most, it’s really just a roof over your head.